In the 20 years prior to Covid, prices didn’t go up that much, about two percent per year. Then boom. Covid hit. Since then, they’ve gone up nearly five percent per year. The world got knocked off it’s orbit.
Why?
Because money got printed. Well, not really printed, as we don’t use much physical cash these days. It got created, through lending and other means, as a result of interest rates getting dropped to the floor at the beginning of Covid, and government spending. Money got added to the supply in too great a quantity, which caused a spike in the inflation rate, and sticker shock on prices.
Inflation has been present throughout history, since money was first created in the sixth century B.C. Governments have used it as a form of (silent) taxation on its citizenry. John Maynard Keynes said, “The power of taxation by currency depreciation is one which has been inherent in the State since Rome discovered it.” It is nothing more than costs by governments being passed on to its citizens. It sometimes can be caused by supply-demand shocks, as it was by oil prices in the 1970s, but it’s mostly driven by governments, creating too much money relative to the existing supply of money—causing a spike in prices.
Many people are blaming the inflation we’ve seen of late on greedy corporations. But, for the most part, corporations are just passing on the cost increases they’ve seen to consumers. They’re protecting their profit margins. The blame should be placed on the governments that have stoked inflation.
Keynes put it like this:
To the consumer the business man’s exceptional profits appear as the cause (instead of the consequence) of the hated rise in prices
Why There’s Inflation
Some governments use inflation to silently rob their citizens of their money, particularly corrupt governments. But in civilized nations like ours, inflation is used primarily to stimulate the economy.
Inflation causes people to spend money—it drives economic growth. If the value of money deflated, if prices decreased, people would reign in spending which would cause a contraction in economic output. The government doesn’t want this.
They want moderate inflation. Their target being two percent.
The inflation we’ve seen since the start of Covid has been above what the government wants. And it has started to cause social unrest. It’s caused people to blame corporations, and question capitalism, which isn’t good.
Unfair
Inflation is unfair to certain classes of society, particularly those who don’t own assets. These individuals see their costs increase with no commensurate increase in the value of their assets, because they have none. The people inflation benefits the most is asset-owners.
Those who own houses have seen the value of their houses nearly double over the past four years. That seems unfair to anyone who doesn’t own a house. Likewise, those who own businesses have seen the value of their businesses increase, as they’ve raised prices and have seen an increase in profits.
Those who don’t own assets have beared the brunt of the prices increases. They’ve seen a modest increase in their wages, and a massive increase in their costs.
This has created a division of the wealth in our country. The haves have gotten wealthier. The have-nots have gotten poorer.
This is the unfair aspect of inflation.
When it spikes, it causes things to really get unfair.
The government should really be held more accountable for this. But I digress.
Why Prices Don’t Stay Flat
In a perfect world, prices would neither increase or decrease. But the world isn’t perfect. There are supply and demand shocks. And there are events which cause the government, at times, to increase the money supply. For instance, for wars and pandemics.
So the choice is between inflation or deflation.
And inflation is the lesser of the two evils.
Keynes put it like this:
Deflation is even worse than inflation. Both are ‘unjust’ and disappoint reasonable expectation. But whereas inflation, by easing the burden of national debt and stimulating enterprise, has little to throw into the other side of the balance, deflation has nothing.
Deflation causes people to become more depressed. To reign in spending. When prices get cheaper, why spend your money? Why not wait for things to get cheaper? That’s exactly what happens. It causes depression.
Inflation, on the other hand, in moderation, makes people feel good. They make more money over time, as their income goes up. The value of their homes increase in value over time, as does the value of their stocks. There are all sorts of psychological benefits to inflation, in moderation, which is why governments favour it.
It’s when it gets out of control that it’s a problem.
Keynes put it like this:
The business world as a whole must always be in a position where it stands to gain by a rise of price and to lose by a fall of price.
Inflation, in moderation, is good for the economy.
Businesses
What happens to businesses when there is inflation is they increase their prices to cover their increased costs. They witness an increase in profits as a result. Which increases the value of the businesses. They are protected, to some extent, from inflation. Which makes them a great hedge against inflation. They protect the money that gets invested in them from inflation.
Stocks, which represent the ownership of businesses, also see an increase in their prices as a result of inflation, as we’ve seen over the past few years as a result of the higher inflation relating to Covid. Since Covid started, the S&P 500 is up nearly 70 percent, beating inflation handily. Stocks have not been harmed by inflation.
John Burr Williams nearly a century ago in his book The Theory of Investment Value described it like this:
Stocks will almost surely rise after inflation, because the capital goods they represent are then possessed of greater earning power in terms of depreciated money.
Sales are higher because the prices of goods and services are higher. They bring in more money, which offsets inflation.
Williams described exactly what happens, and has happened, when inflation sets in:
When inflation first threatens, a company’s bonds should drop and its stocks should rise at once . . . Then, after inflation really begins, the bonds and stock should both start to rise in investment value expressed in depreciated money, and should both continue to advance until the inflation is over.
Inflation causes stock prices to permanently adjust upwards, as the profits and value of those businesses permanently increase.
Bonds
The riskiest investments when inflation rears its head are bonds, especially at low interest rates as we had a few years ago. When you lock into a bond (or GIC) for a long period of time at two percent interest, and inflation increases to 5 percent, you’re losing money after inflation—and the value of that bond (or GIC if it were quoted) is going to get hammered.
That’s exactly what has happened. Bond prices from two or three years ago are still down significantly. They haven’t recovered, and won’t until interest rates come back down. And they may never come back down to two percent. So those who locked in at a two percent interest rate may never recover the value of their investments. Locking in at a low rate was risky. It always will be with inflation.
Conventional wisdom is that bonds are safe. But this isn’t always true. Bonds are safe when they pay a reasonable interest rate. I don’t think many looking back today would say two percent was reasonable.
Protect Yourself
The best way to protect yourself from inflation, long term, is to own stocks, which, as I described, are able to pass price increases on to consumers, and benefit from inflation. When you own stocks you have a natural hedge against inflation.
When you own bonds you want to ensure you’re being adequately paid on them, otherwise they are risky, particularly if you’re locking in for a period any longer than a year. The longer you lock in, the riskier they are.
Threat
Inflation might be coming back down to earth. But the threat of it always looms. No one foresaw the inflation of the 1970s, but it happened, and rocked many peoples’ worlds. From 1973-1982, inflation raged at 9 percent per year in the U.S. Nine percent. Think of how brutal the inflation we’ve had over the last few years has seemed. Imagine prices going up at 9 percent per year for a decade. Goods and services that cost $100 at the beginning of 1973 cost $230 by the end of 1982. It was a brutal period. The value of a dollar was worth less than 45 cents by the end of it.
Stock prices over this period nearly doubled, protecting investors’ money almost entirely from inflation. Businesses protected investors’ capital.
Bonds, meanwhile, failed to protect. Anyone who locked into a 10-year bond in the early 1970s at 6 percent interest (which no one at the time thought of as being low) was underwater on their investment after inflation for the next decade.
The Lesson
Be careful of investing in bonds when interest rates are low. They won’t protect your money.
Stocks meanwhile, though more volatile in the short term, will do a better job of protecting your money against inflation over the long term.
Bottom Line
Inflation will always exist. Prices ain’t ever going down.
Protect yourself from inflation by owning assets, in particular businesses that are able to increase prices to offset inflation.
And, when someone blames corporations for inflation, politely correct them and tell them it’s not corporations that cause inflation, but rather, the government.